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Oil Seen Selling Off Quickly If OPEC Doesn't Extend Production Cuts

3 May 2017 5:00 am
By Georgi Kantchev 

The price of oil is susceptible to a swift selloff should OPEC and other major producers not agree to an extension of crude production cuts this month, analysts say.

Oil markets have largely priced in an extension to the deal struck between OPEC, Russia and other producers late last year.

If that deal isn't extended, prices could drop below $40, a level not seen for over a year, some analysts say.

If the output cuts are extending when the Organization of the Petroleum Exporting Countries and other suppliers meet on May 25, oil prices would rise to $60 a barrel by the end of the year.

"The market appears to have largely priced in an extension to the output-cut deal," said Warren Patterson, commodity strategist at ING Bank. "This is a significant risk for the market, with no deal likely to lead to an aggressive selloff."

Brent crude will average at $57 a barrel this year, reaching $60 in the fourth quarter, according to a poll of 14 investment banks surveyed by The Wall Street Journal in late April. That is broadly unchanged from the previous survey. The banks expect West Texas Intermediate, the U.S. oil gauge, to average $55 a barrel this year.

Oil prices have risen by more than a tenth since OPEC and other producers agreed to cut around 2% from global production late last year. These producers will now meet in Vienna to decide whether to extend that deal for another six months.

Most analysts expect the producers will agree to do that. The nearly three-year old oil glut continues to weigh on the market, which has traded mostly above $50 a barrel this year but is still down more than a half from its levels in mid-2014, when the downturn began.

Saudi Arabia's energy minister Khalid al-Falih last month said that a preliminary agreement to extend the cuts had been reached, but it still needed a final signoff from some OPEC members.

But renewing the agreement is far from a done deal.

The fact that it encompasses so many countries represents its 'Achilles' heel,' analysts at J.P. Morgan say.

If even one OPEC member rejects the extension the rest of the group would quickly shift their strategy to increase output. That would have "dramatic implications for price levels," according to the bank.

And even if OPEC does reach a consensus, the deal will still hinge on whether 11 suppliers from outside the cartel will join in, as they did last December. If the negotiations fail, analysts at Citigroup and J.P. Morgan both predict that oil prices will fall below $40 a barrel.

All these producers also face a challenge from a party that won't be present in Vienna: U.S. shale producers.

If a renewed deal sends oil prices higher, shale producers would be incentivized to ramp up activities, adding new barrels to the glut. U.S. oil production has been on the rise since September and the U.S. Energy Information Administration expects the country's output to rise to 9.9 million barrels a day next year, the highest level on record.

"Today's [OPEC] actions in support of prices are laying the foundation for tomorrow's oversupply," J.P. Morgan said.

The speed with which shale drillers can ramp up activities is faster than most oil production and this will provide a cap to prices going forward, analysts say. The banks in the Journal survey expect Brent to rise to an average of $62 a barrel next year and $65 a barrel in 2019.

"The unconventional revolution looks unstoppable," said Citigroup.

Write to Georgi Kantchev at georgi.kantchev@wsj.com

(END) Dow Jones Newswires

May 03, 2017 01:00 ET (05:00 GMT)

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